Author Archives: Dan Popescu

The Inflation Illusion

We hear more and more talk about the possibility of imposing negative interest rates in the US. In a recent article former Fed chairman Ben Bernanke asks what tools the Fed has left to support the economy and inter alia discusses the use of negative rates.

We first have to define what we mean by negative interest rates. For nominal rates it’s simple. When the interest rate charged goes negative we have negative nominal rates. To get the real rate of interest we have to subtract inflation from the nominal rate, so to speak remove the illusion of inflation.

Changing Attitudes

With the help of a set of excellent charts on gold imports vs exports by Nick Laird (www.sharelynx.com), I would like to give you a brief overview of where gold is going. We have heard for some time that gold is moving to the Far East but is it really only moving there?

Keeping it Simple

In this article I want to approach the idea of a gold standard from a more “regular people” perspective rather than from a “high academic” economic/finance and, sometimes, legalistic perspective. I constantly read books and articles full of mathematics written by the economic academia, trying to show why a gold standard is a relic of Antiquity, unsuitable for the modern world.

Still, as a physicist, I would like to remind economists that they would not be able to write their papers on a PC, communicate with an iPhone, drive a car or fly on a plane, if it weren’t for two relics of Antiquity essential to scientists and more than 3,000 years old that have barely changed since then: algebra and geometry.

The Global Monetary Architecture: Change is on the Horizon

There is no better way to descibe the international monetary system today than through the statement made in 1971 by U.S. Treasury Secretary, John Connally. He said to his counterparts during a Rome G-10 meeting in November 1971, shortly after the Nixon administration ended the dollar’s convertibility into gold and shifted the international monetary system into a global floating exchange rate regime that, “The dollar is our currency, but your problem.” This remains the U.S. policy towards the international community even today. On several occasions both the past and present chairpersons of the Fed, Ben Bernanke and Janet Yellen, have indicated it still is the U.S. policy as it concerns the dollar.

Shocking the Markets

“Money is sound when it fulfills its functions as a means of payment and store of value as smoothly and reliably as possible in people’s everyday lives. Sound money retains its value and is generally accepted. It also makes an important contribution to social harmony and material prosperity. Sound money is therefore a central pillar of our [Swiss] society. The mandate of monetary policy is to ensure that money remains sound. Consequently, the Swiss National Bank (SNB) bases all of its activities on this mandate.”

Thomas Jordan, Chairman of the Governing Board of the Swiss National Bank, Nov. 23, 2014 just before the Gold Referendum on Nov. 30, 2014

I expected a positive outcome in the Swiss Gold Referendum (Nov. 2014) to create a tsunami in the gold and foreign exchange markets but I didn’t expect the tsunami created by the unpegging of the Swiss franc (Jan. 2015); especially after the absolute assurances given by the Swiss National Bank (SNB) during the referendum campaign. If the negative vote in the Swiss gold initiative was not a surprise, the de-pegging of the Swiss franc only a month and a half later was.

Hypothesis for 2015

Before I go into the five reasons to buy gold in 2015, let me go through four hypotheses for the future price of gold and silver.

The first hypothesis is that the present bear market is not finished and it will have another one or two legs down, all the way to where it started at $300. On a technical basis, it can be defended if you believe $1,900 was the end of a bubble that started in 2000. I don’t believe so. Many other technical, but also fundamental factors cause me to assign a very low probability to this scenario.

Introductory remarks by Pater Tenebrarum:

We have recently discussed the backdrop to the Swiss gold referendum in these pages (see: “Switzerland’s Referendum on Gold” for details), pointing out that the Swiss National Bank is no different from other central banks in terms of its money printing proclivities. In fact, it is even worse, if we merely look at the money supply expansion in Switzerland since 2008 (and they are afraid of “deflation”, which is surely the height of absurdity).

Egon von Greyerz similarly notes that Swiss monetary policy has slowly but surely gone from prudence to “what everybody else is doing”, which is actually quite contrary to Swiss tradition. Consequently, the Swiss Franc is actually rather risky these days. He makes the additional important point that the Swiss banking industry is extremely large relative to the country’s economic output, a fact that brings its own risks with it (as e.g. the Cyprus debacle has shown).

Swiss citizens take their referendums seriously – direct democracy is cherished in Switzerland and people generally participate quite actively. We also noted that what might be loosely termed “conservative” and even – gasp! – libertarian causes often tend to find the necessary support, while the Swiss have usually proved to be quite sane on the question whether socialist measures should be introduced (see e.g. our previous missive “The Swiss Remain Sane” for a pertinent example). They hate being dictated to and at times their decisions are greeted with howls of outrage by etatistes around the world, always proof positive that the decisions were the right ones.

Switzerland’s economic freedom score is 81.6, making its economy the 4th freest for the first time ever in the 2014 Index. Its score is 0.6 point higher than last year, with improvements in trade freedom and the management of public spending partially offset by declines in monetary freedom and labor freedom. Switzerland is ranked 1st out of 43 countries in the Europe region.Read More About Switzerland

As you can see, there is some scope for improvement in the area of “monetary freedom”. We assume, meaning: scope for reducing central bank intervention in the economy. The Swiss now have the unique opportunity of achieving just that. At this point in time polls show the two camps running neck-on-neck, with the yes vote enjoying a small lead. So it is still too early to call the outcome of the referendum.

The Swiss government and the SNB are working overtime trying to convince the population against reducing the central bank’s flexibility, but as noted above, the Swiss don’t like being told what they are supposed to think (least of all, we assume, by a bunch of Keynesian dunderheads). So there is actually a reasonably good chance this initiative will fly.

Bottom or Continuation Formation?

After the original drop in gold price from the top of $1,920 per ounce in 2011 to $1,180 per ounce in 2013, gold has started a sideways consolidation triangle pattern. Is this a correction, or is it just a pause within a move that will retrace the whole move since 2009? What does sentiment tell us?

The gold market is a very opaque one and very hard to analyze. The amount of gold exchanging hands outside the markets is enormous. China seems to continue buying in a very discrete way and shows regularly, through speeches but also actions, that it considers gold at the core of its currency war, mainly with the United States. It is interesting that recently, on every attack on the gold price to push it down, once the original move stops, almost every time momentum fails to take gold lower. This pattern doesn’t look like a correction in a bear market to me, but more like a bottoming formation.

Interview with Ronald-Peter Stöferle: Monetary Tectonics and Gold

Dan Popescu of Goldbroker has interviewed our good friend Ronald-Peter Stöferle of Incrementum Liechtenstein AG, co-author of the In Gold we Trust 2014 report .

“We are currently on a journey to the outer reaches of the monetary universe. We believe that the monetary experiments currently underway will have numerous unintended consequences, the extent of which is difficult to gauge today. Gold, as the antagonist of unbacked paper currencies, remains an excellent hedge against rising price inflation and worst-case scenarios.

The tug-of-war between a deflationary debt liquidation and politically induced price inflation is well and alive. Last year we coined the term ”monetary tectonics” which describes the battle between these powerful forces. An excellent indicator for the interaction between inflation and deflation is the gold/silver ratio. One could therefore also refer to the gold-silver ratio as the “deflation/reflation” ratio.”

India’s Role in the Gold Market

India is now, according to The World Gold Council (WGC), the world’s second biggest consumer of gold having been surpassed by China. However, India remains a major player in the gold market. In this article, I will look at the importance of India in the gold market. In India, gold is religion. India's love affair with gold is timeless, spanning centuries even millennia. Roman historian, Pliny, lamented some 1800 years ago, how India, the sink of precious metals, was draining Rome of gold, an appellation that resonates even today. Indians see the metal as a symbol of purity, prosperity and good fortune. Although estimates vary, India is now thought to hold close to 18,000 tonnes or 10% of the world’s entire above-ground gold stocks. Seven percent of India’s total household savings is currently held in gold.(1) Gold purchase in India is entwined with religious and cultural beliefs. According to the WGC, in the last decade, 75% of gold demand in India has taken the form of jewelry. Also, according to the WGC, “To make a distinction between investment and jewelry demand is to misunderstand Indian attitudes: they are often the same.” (1) More than two-thirds of that demand comes from the country’s rural population. Gold is the second largest import item for India after petroleum. Over 90% of the gold consumed in India is imported. A French visitor to India, Francois Bernier, enviously wrote how “It should not escape notice that gold and silver, after circulating in every other quarter of the globe, come at length to be absorbed in Hindustan.” (1)

The performance of gold in Indian rupees certainly confirms that gold for Indians is an excellent hedge against inflation and devaluation of their fiat currency. Gold has, since 2000, increased close to ten times in rupee terms and, even after the recent drop, it is still seven times higher than its 2000 level.

Gold and Geopolitics

“Gold is the sovereign of all sovereigns”

Democritus

They say that gold is a geopolitical metal. Gold is real money with no counterparty risk and, furthermore, an excellent wealth preserver in time and space. Like fiat currencies (dollar, euro, yen, Yuan etc.), gold’s price is also influenced by political events, especially those having an international impact. Alan Greenspan, ex-chairman of the Federal Reserve, said that gold is money “in extremis”. This is why gold is part of most central banks’ reserves. It is the only reserve that is not debt and that cannot be devalued by inflation, contrary to fiat currencies.

Observe in chart #1 that central banks own 30,500 tonnes of gold, or 19% of above ground gold. However, this number is an underestimation, because several countries (e.g. China, Saudi Arabia) report only a portion or none at all of their gold holdings. In addition, if they do, they do not do it in a timely manner.

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